Why regulators need to take another look at bank capital

In the 10 years since the financial crisis, regulators and banks have made many changes to strengthen the financial system. There’s perhaps no bigger change than the significant increase in the amount of capital banks of all sizes now hold as an insurance policy against losses.

We agree that these higher capital levels have helped to make the system safer, but asking banks to hold too much capital, the wrong kind or making the calculation methodology too complex can also have negative repercussions for consumers and the broader economy.

Now is the right moment for regulators to get bank capital levels right, so banks can fully support the communities they serve, without compromising the safety and soundness improvements over the last 10 years. We’re pleased to see regulators asking the right questions, namely, “Are there ways to make improvements?”

Banks finance their operations in a number of ways, but capital is fundamental. Before gathering deposits and taking on debt comes capital. Because of the risk to investors, it is also the most expensive.

Capital stands as a wall between those who lend to banks and a loss on their investment. But only the earnings left after paying depositors, creditors and everyone else — the profits — go to the capital investors. Too much capital, and those profits can be spread very thin, discouraging existing capital backers and making it hard to get new ones. Too little capital, and creditors become nervous. So do regulators.

That’s why adequate amounts of high quality capital are a shared interest of bank management and bank supervisors. The very appropriate question that bankers and regulators are asking is, “Does it really take thousands of pages of regulation and guidance to give life to that basic principle?” Earlier this year, when Federal Reserve Vice Chairman for Supervision Randal Quarles counted 24 different capital and other loss absorbing requirements, he concluded, “I am reasonably certain that 24 is too many.”

Quarles noted that “it is inevitable that we will be able to improve” the prudential regulations of recent years, “especially with the benefit of experience and hindsight.” That process is ongoing, in a careful, considered and measured way. The exercise is not one of a regulatory pendulum swinging one way or another, but rather a national effort to get the rules right. We need to support that work.